Conditional Dynamics and the Multi-Horizon Risk-Return Trade-Off
We propose testing asset-pricing models using multi-horizon returns (MHR). MHR effectively generate a new set of test assets that are endogenous to the model and that identify a broad set of possible conditional misspecifications. We apply MHR-based testing to prominent linear factor models and show that these models typically do a poor job of pricing longer-horizon returns, with pricing errors of similar magnitude as the risk premiums they were designed to explain. We trace the errors to the conditional factor dynamics. Explicitly incorporating factor timing in the models often makes mispricing worse, posing a challenge for future research.
Published Versions
Mikhail Chernov & Lars A Lochstoer & Stig R H Lundeby, 2022. "Conditional Dynamics and the Multihorizon Risk-Return Trade-Off [New and old characteristic-sorted portfolios: Implications for asset pricing]," Review of Financial Studies, Society for Financial Studies, vol. 35(3), pages 1310-1347. citation courtesy of 
Related
More from NBER
In addition to working papers, the NBER disseminates affiliates’ latest findings through a range of free periodicals — the NBER Reporter, the NBER Digest, the Bulletin on Retirement and Disability, the Bulletin on Health, and the Bulletin on Entrepreneurship — as well as online conference reports, video lectures, and interviews.
